When Iran sanctions bite

In recent years, India has found itself caught not only in the bitter US-Iran rivalry but also in the efforts by the wider international community to sanction Iran, particularly in its energy sector. Media reports and pressure from US lobby groups (including a letter from America’s influential American Jewish Committee) even forced the Indian embassy in DC to actually clarify, if not defend, its position on the West Asian (or Middle Eastern) country.

There are multiple layers of sanctions levied on Iran, primarily by three entities – The United Nations (UN), the United States (US), and the European Union (EU). These sanctions cater to a wide range of purposes. The New York Times captures this in a helpful infographic.

The UN Security Council, for instance, has imposed several sets of sanctions from 2006. It banned the trade and supply of nuclear materials, froze the financial assets of people and entities involved, and prevented financial institutions from lending money to activities deemed related to the Iranian nuclear program. The council also enforced an arms embargo.

Even though the United States began sanctioning Iran from 1979 (after the US embassy hostage crisis), it was only in 2007 that Washington first penalised the country for weapons proliferation. The most recent wave of sanctions since 2010 have been the toughest ever levied by US on any country. As International Crisis Group analyst Ali Vaez notes, these sanctions targeted “almost every major chokepoint in Iran’s economy.”

By mid-2012, US president Barack Obama gave the US Treasury Department authority to identify and sanction foreign persons who helped Iran evade the US or multilateral sanctions. In January 2013, the country also clamped down on hawala (informal banking and money exchange) transactions across the Middle East and South Asia regions (For a detailed assessment of the US sanctions read the Congressional Research Service report). This last wave of sanctions was particularly painful not only for Iran but also countries that continued to be its energy partners, like India.

The debilitating effect of unilateral US sanctions was further compounded by the European Union – which until then promoted “critical dialogue” over coercive tactics – decided to play tough in step with the United States. Until 2009, the EU focused on discouraging companies from doing business with Iran. The Iranian presidential election protests and resulting crackdown that year (along with the failed fuel swap deal) changed that. The EU imposed tougher measures which included a ban on investing in Iran’s oil and gas sector.

With the International Atomic Energy Agency (IAEA) raising serious concerns over the progress of the Iranian nuclear program in November 2011, the United States’ enforced unilateral sanctions. Following this, the EU imposed its own oil embargo and froze assets of the Central Bank of Iran.

Further stringent measures included the expulsion of Iranian banks from the global electronic banking system (SWIFT) which made it nearly impossible for Iran to engage in international trade. Cornelius Adebahr, Associate (Europe Program) at the Carnegie Endowment for International Peace observes that the EU set in place “the broadest and most comprehensive sanctions regime it had ever imposed.”

All the above sanctions combined ensured that during 2012-2013 Iran lost revenues from oil, the value of the Iranian rial plummeted, inflation rose to over 50 percent and the country had no access to a large chunk of hard currency it held abroad. In sum, the Iranian economy shrank by 5.4 percent.

Its effect on India was three pronged. The first problem was with respect to reducing imports and reconfiguring refineries. The immediate challenge India faced in the rapidly changing energy market was the reduction of Iranian imports and the simultaneous reconfiguration of its refineries to process crude oil from a different source. Iran offers sweet light crude and the readily available alternate from Saudi Arabia was too heavy, sour and hence unsuitable for India’s older refineries. So cutting down oil imports from Iran was only one part of New Delhi’s problem. Replacing those amounts with a different source, like Saudi Arabia or Iraq, meant processing a whole new type of crude oil, and that was a costly affair. With the majority of Indian refineries being government-owned, New Delhi would have to foot that bill.

Given these circumstances, India argued that in the near term it could not completely halt Iranian imports because of two main reasons. First, the technical requirements and pricing methodology of Iranian crude made it difficult to hastily source from other Middle Eastern countries. Second, Iran’s 90-day credit line was more helpful in improving refining margins than the 30-day credit the Saudis and other Middle Eastern countries offered.

By this time the United States had granted a waiver to India but in order to renew it, the country would have to continue demonstrating “significant reduction” in Iranian oil imports. Interestingly, the American legislation (Section 1245 of the National Defense Authorization Act for 2012 (NDAA) does not define how much reduction qualifies as ‘significant’. With the ball left completely in India’s court, New Delhi opted to mitigate the problem in the medium term by first, drastically reducing Iranian dependence; second, increasing imports from Saudi Arabia and Iraq; and third, diversifying further into Latin American and African sources.

India’s Iranian oil imports dropped by about two-thirds from 315,200 barrels per day (bpd) in 2012 to 195,600 bpd by 2013. Most refiners either halted business or cut back based on commercial considerations and imports automatically fell further than the targeted 15 percent reduction mark with the threat of ‘over-compliance’ becoming a reality. Iran now slipped from being India’s second largest supplier of crude to seventh place.

The second concern was the often raised payment issue. Observing the increasing pressure on Iran, India had by mid-2011 stopped paying for oil imports through Iran’s central banks. When the new round of US sanctions hit later that year, Indian refiners were working through the Turkish bank Turkiye Halk Bankasi AS to route payments in euros to Iran.

It was the European Union’s decision to place its own embargo on Iran’s oil from July 2012 that further reduced India’s payment alternatives. Iran’s expulsion from the electronic banking mechanism SWIFT also complicated matters for parties still trading with Iran.

However, if one could call it a weak silver lining, the EU sanctions gave India the upper hand in the selection of a new payment route. Tehran now accepted payment for oil in rupees – a proposal it had vehemently resisted before, This was done through its private Parsian Bank with India’s UCO Bank. The rupee payment mechanism would allow India to pay for 45 per cent of oil purchase in its local currency.

The third problem was regarding maritime (re)insurance.The EU embargo on Iranian oil in 2012 prohibited EU insurers and reinsurers from covering Iranian oil shipments. European insurance clubs handle a majority of the world’s tanker insurance (95 percent of the world’s tanker fleet). This ban on marine insurance – both reinsurance and liability coverage – became the most effective stranglehold on Iran. The measure single-handedly cut the nation’s crude exports by more than 50 percent. And this move unquestionably sealed the disruption of Iranian oil supplies to India.

Oil firms usually buy insurance to protect their crude cargo while shipping companies purchase cover for the vessel (hull & machinery – H&M insurance) as well as liability from oil spills, other pollution claims and personal injury (protection and indemnity – P&I insurance).

More often than not, such coverage offered by Indian insurers is a far cry from the amounts received from European firms. With the EU ban, Indian insurers, unwilling to take a risk, denied coverage to Indian shipping companies and refiners. Iranian insurers stepped in to fill the void but most companies and countries ruled out doing business with them. Mangalore Refinery and Petrochemicals Ltd (MRPL) was the sole refiner that resorted to securing coverage from an Iranian insurer in May 2012 after its policy with New India Assurance Co Ltd lapsed.

In the meantime, the Indian government’s proposal to set up a Rs. 2,000 crore oil insurance pool fund failed to take off. The sovereign fund was to be financed by the Petroleum Ministry and state insurers, led by the General Insurance Company (GIC). The interim nuclear deal negotiated between Iran and the P5+1 countries in November 2013 presented yet another reason for the fund to be deemed unnecessary.

So what changed in the interim deal?Under the pact, Iran was granted access to $4.2 billion in oil revenues held by its buyers. This amount was to be paid out in eight money transfers until the month of July (initial deadline for final deal, talks now extended to November). On India’s part, five Indian refiners made payments equal to $1.65 billion in three installments through the UAE central bank. They still owe Iran about $2.96 billion. New Delhi also allowed Iran to use the money parked in Indian accounts to pay for humanitarian goods (exempted from sanctions) such as food and medicines bought in third countries.

The US also suspended sanctions on fourteen major Iranian petrochemical companies facilitating purchases for Asian buyers while the EU lifted its ban on insuring and transporting Iranian oil for six months. However, until very recently Europe-based insurance clubs seemed hesitant to grant cover given the reversible nature of the interim deal.

The terms of the interim nuclear deal can change within short notice if the talks break down at any point. Also, the reversal of certain sanctions does not necessarily do away with other significant practical problems in trading with Iran. Keeping these moving pieces in mind, India continues to engage Iran with caution.

(This is the first part of a three part series looking at Indo-Iran relations.)